Leaders under pressure in Europe budget debate

Simmering problems in Europe again rattled global sharemarkets overnight, as European leaders arrived in Brussels to commence tense negotiations over the region’s long-term budget.

The squabble over the 2014-20 budget is shaping up as a fight between British demands for a budget freeze, and French demands for more spending. Herman Van Rompuy, the head of the European Council, is expected to unveil a compromise €960 billion budget – equal to around 1 per cent of the region’s annual GDP – that largely maintains spending on the two main items of the budget- regional aid and agriculture.

European leaders are under pressure to reach a deal at this summit, after their previous attempt in November failed. Analysts have warned that if an agreement isn’t reached in coming days, market confidence could be disrupted and billions of dollars in spending under various European Union projects could be at risk.

All the same, German chancellor, Angela Merkel, said she was not sure whether agreement would be reached, because “the positions are still far apart". For his part, French president, François Hollande, said that although France recognized the importance of making savings, “it’s important not to weaken the economy".

Meanwhile British prime minister, David Cameron, argued that the European Union “should not be immune from the sorts of pressures that we’ve had to reduce spending, find efficiencies and make sure that we spend money wisely, that we are all having to do right across Europe", and warned that there would not be a deal without more budget cuts.

The dispute over the European budget comes as Citigroup’s highly regarded chief economist Willem Buiter has warned that although the European Central Bank has reduced some risks, the region still lacks an engine for sustained growth.

In a recent note, he points out that private sector debt remains high in the eurozone, and that although most countries are cutting their budget deficits, their debt levels are continuing to rise. As a result, he warns, “continued fiscal austerity thus remains all but certain" in many eurozone countries.

At the same time, many banks, both in the core and the periphery of the eurozone remain weak. As a result, “the path to economic recovery, let alone sustained growth at an attractive growth rate of potential output remains an arduous and long one."

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Buiter also warns that investors have misinterpreted the back-stop now being provided by the European Central Bank. He says that the ECB has protected European banks against systemic collapse by providing plentiful liquidity to European banks. And its promise to buy the bonds of debt-laden countries has meant there is no longer a risk that the eurozone will break up as a result of a debt-laden country being forced to leave.

But, he says, its important to recognize that unsecured bank creditors may still be at risk in future bank bailouts. He warns that the additional capital needs of eurozone banks, combined with the limited resources of eurozone countries and political opposition to using taxpayer funds to protect bondholders “make it likely that bail-ins of senior unsecured bank creditors in the euro area will start before 2015. The economic and financial risks facing the euro area are not only driven by governments and politics."